The Apple iPhone, App Store, and AAPL

The introduction of the iPhone in Canada heralds the beginning of a new era in mobile communications.

Though referred to as a phone, it is much more.It is a networked portable computer with a revolutionary user interface.It portends the mass market emergence of the mobile Internet – the Internet in your pocket.As a platform, it is as revolutionary as the first IBM PC.Though, just as with the early days of the personal computer, there have been other smart phones on the market for several years, the iPhone arrives with the ecosystem elements to drive the smart phone into the everyday lives of consumers.

The iPhone ecosystem combines lessons learned from Apple’s history in computing and Apple’s more recent dominance in a once fragmented music player market.Apple is one of a few companies that has a corporate memory that spans the entire period of the personal computer industry, from the emergence of the first personal computers in the mid-1970’s to the present day mass market ubiquity.Steve Jobs, the Apple CEO, helped invent one of the early personal computer businesses in Apple and saw it through several cycles of successes and failures, developing an unparalleled understanding of the zeitgeist of the computing era and technology consumer market.Apple applied this learning to the fragmented mobile music player market.Realizing, from the history of computing, that the value of hardware, or the music player, was greatly driven by the value of the software, or the music itself, to the end consumer.To this end, while other mobile music players relied on consumers to find their own methods to convert music to MP3 files and load the music onto their music player, Apple built a simple and elegant ecosystem, combining iPod hardware with the iTunes music store for easy discovery of music, easy purchase of music, and easy mobile enjoyment of music.For music creators, it facilitated an easy way to access a large market of consumers and an easy way to charge and collect for electronic music sales.

In the same way, the longer term market opportunity around the iPhone is not about just the hardware.No doubt the hardware is more elegant and has an ease of use unparalleled in previous smart phone hardware.The iPhone differentiates itself from previous smart phones through its consumer and developer friendly ecosystem.It’s about the software again.Just as Apple learned with personal computers and with the iPod, innovative software and killer applications will drive hardware sales.To this end, Apple has built very tight integration between the iPhone and its new App Store.The App Store is essentially an iTunes type store for iPhone software.Apple has made it incredibly easy for consumers to discover new software, purchase new software, and enjoy new software on the iPhone.For the other side of the ecosystem, for developers of mobile software, the App Store enables easy access to a large market of end software customers, taking care of the difficult challenges of being discovered, conducting a sales transaction, and then getting paid for the sale.This integrated ecosystem creates a well greased reinforcing loop.A large number of iPhones sold with an installed and simple App Store leads to a large and easily accessible market for software innovation.This leads to a great amount of software development which in turn increases the likelihood of the development of a killer application.Killer applications in turn drive more iPhone sales.RIM, Samsung, Nokia, HTC, and other smart phone makers will continue to improve their hardware and have tried to run App Store type software development and distribution models in the past but they have always missed key components – whether they be ubiquitous distribution, or ease of purchase, or ease of payment and collection. In many cases, they have been forced to cede control of the software portal to the cellular carrier who has in turn outsourced it to a wireless portal company. This non-strategic and fragmented approach has led to slow adoption of mobile phone applications.

Apple on the other hand has leveraged its learning from the personal computing wars and its test case in the music player world to start what could develop into a de-facto market dominating position in the smart phone market by closing the hardware-software loop.

So what does this have to do with the stock (AAPL)? Buy it. With the iPhone and the App Store, Apple has the potential to develop a mobile platform near monopoly. Similar to what Microsoft was able to do with DOS/Windows and Apple was able to do with the iPod. An ecosystem with a positive loop network effect can quickly eat market share in a fragmented market. All the pieces are in place and the next couple of years should be very interesting.